So that's that. Britain is about to undertake the world's greatest commercial experiment. Last week, the Treasury made a multi-billion-pound, 30-year commitment to two private, untried consortia to refurbish the London Underground around a structure that no other Western finance ministry has yet contemplated. This is a gamble politically, financially and in terms of transport policy.

For London's transport system matters. After decades of relative economic decline, Britain has begun to find itself the beneficiary of new economic and social forces. Globalisation works to our advantage. The flows of inward investment, our place in the system of international air travel, our hub role in the global information and communications network, our energy industries and our strength in sectors like art, education and auctioneering are all flowering.

Our number one asset is London, already established with New York as one of the two global city leaders, and which, if managed correctly, could make it the world's leading city, with all that implies for Britain's economy. London already has the world's busiest airport, biggest international financial markets and more multinational corporate headquarters than any other city on earth. Its property boom is testimony to its growing economic power, spearheading Britain's wholly accidental yet successful exploitation of globalisation.

But London's success is increasingly threatened by a public transport system that has become a global byword for inadequacy. Movement around the capital, especially at rush hours, is slow, unpredictable, expensive and acutely uncomfortable. London needs a wholesale modernisation and vast extension of the capacity of the Underground.

It is by these criteria that the London Underground Public Private Partnership (PPP) must be judged - and by which it fails. For all the talk of £16 billion of new investment over 15 years, what this will buy falls far short of what is needed. Only 12 new trains will be in service by 2008, and it will not be until 2019 that rolling stock more than 10 years old will be fully replaced. Modern control systems will not be in place until 2016. Modest increases in capacity and reductions in delays will take between seven-and-half and 10 years to kick in - and are all dependent on the Treasury and the consortia striking a deal for the second seven-and-a-half year contract period. The priority, extraordinarily, is a massive programme of station refurbishment, presumably to throw up substantial property profits, so delayed travellers will be able to shop freely to divert themselves while they wait.

Yet to get this modest and delayed improvement, the Treasury is raising its support to London Underground Limited (LUL) by more than half, to £750 million a year for at least the next seven- and-a-half years, by its standards a monumental commitment. But it has made an elementary mistake. Large-scale capital investment cannot be financed on a 'pay as you go' basis, anymore than you and I could buy our houses without a mortgage. The usual procedure in capital investment is to borrow for the investment and use the annual income stream to service the debt. Thus, in London Underground's case, you would borrow £10bn to £12bn now to invest in new capacity and rolling stock to get a modern Underground, and service the resulting debt from income over the next 20 to 30 years. This concept is championed by Bob Kiley, Ken Livingstone's transport supremo.

The trouble is that the PPP is structured so that only the two private consortia to whom the Tube's infrastructure is transferred can borrow for investment and, as a result, the scale is hopelessly inadequate. Out of £16bn projected for investment over the next 15 years, only £3bn will be borrowed, so we have to acquire trains, rolling stock and new signalling out of our annual income on a 'pay as you go' basis, which is why it will only be in 2019 that all 10-year-old trains will finally be out of service. This is toytown economics and has made London an international laughing stock.

The reason why is that the Government and Treasury do not trust the public sector to manage large-scale infrastructure projects. The Treasury could only be persuaded to untie its purse- strings if the public sector passed the entire ownership and management of the infrastructure to the private sector. The Treasury would have preferred wholesale privatisation, but it had to respect New Labour's manifesto promise that the Underground remained under public direction, hence the curious PPP. LUL operate the trains and collect the fares; the private sector owns, finances and maintains the infrastructure with the two sides yoked together through the most complex commercial contract Britain has witnessed.

But the much vaunted private contractors pitched their bids 4 per cent higher than the public sector estimated its costs to do the same job. The only way the PPP could be justified was after the accountants and consultants estimated that if LUL stayed in charge the bill would be a cool £4.3bn higher in cost overruns. The figure is a complete guess, based on the belief that LUL is incapable of learning from past mistakes. Nor is there any compensating figure for what having a modern Tube system in five years might be worth to London if it could use a grown-up approach to financing; nor is there any estimate for possible private-sector failures because it is assumed the private sector is perfect, as if Marconi, Equitable Life and Railtrack had never happened.

In the hundreds of pages of reports by PwC, Ernst & Young, and London Underground I have read over the last 18 months, there is not a single chapter discussing why it might be that LUL is inefficient and what the right managerial responses might be. Why is public procurement and management of the infrastructure poor? Why does the public sector suffer cost overruns and is it really worse than the private sector?

If we had wanted a modern Tube system fast, the right approach would have been to fix LUL's organisational weaknesses and allow it to borrow the billions needed now, asking the private sector to tender for the business. The same companies now sitting on guaranteed 18 per cent returns on shareholders' funds for 30 years would have pitched for the work but on tighter margins, and London would have the transport system it needs within the next five years rather than in the distant future. It is a massive missed opportunity - and very, very British.